UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2012

[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ____________ to ____________

Commission File Number 0-22334

LodgeNet Interactive Corporation

(Exact name of registrant as specified in its charter)

Delaware		46-0371161
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)

3900 West Innovation Street, Sioux Falls, South Dakota 57107

(Address of Principal Executive Offices) (ZIP code)

(605) 988-1000

(Registrant’s telephone number,

including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes X No___

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ___		Accelerated filer X		Non-accelerated filer ___		Smaller reporting company___
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X

At November 5, 2012, there were 26,831,911 shares outstanding of the registrant’s common stock, $0.01 par value.

Table of Contents

Part I — Financial Information

Item 1 — Financial Statements

LodgeNet Interactive Corporation and Subsidiaries

Consolidated Balance Sheets (Unaudited)

(Dollar amounts in thousands, except share data)

	September 30,		December 31,
	2012		2011
Assets
Current assets:
Cash	$	18,702	$	14,019
Accounts receivable, net	43,658		53,963
Other current assets	11,772		11,021
Total current assets	74,132		79,003

Property and equipment, net	109,610		119,164
Debt issuance costs, net	2,682		4,373
Intangible assets, net	84,988		91,642
Goodwill	7,467		100,081
Other assets	12,866		14,409
Total assets	$	291,745	$	408,672

Liabilities and Stockholders’ Deficiency
Current liabilities:
Accounts payable	$	61,405	$	48,255
Current maturities of long-term debt	346,741		10,395
Accrued expenses	15,132		18,813
Deferred revenue	17,899		19,949
Total current liabilities	441,177		97,412

Long-term debt	645		352,905
Other long-term liabilities	6,903		9,296
Total liabilities	448,725		459,613

Commitments and contingencies

Stockholders’ deficiency:
Preferred stock, $.01 par value, 5,000,000 shares authorized;
Series B cumulative perpetual convertible, 10%, 57,500 issued; 57,266 outstanding at September 30, 2012 and December 31, 2011, respectively (liquidation preference of $1,000 per share; $57,266,000 total at September 30, 2012 and December 31, 2011, respectively)	1		1
Common stock, $.01 par value, 50,000,000 shares authorized;
26,157,309 and 25,272,734 shares outstanding at September 30, 2012 and December 31, 2011, respectively	262		253
Additional paid-in capital	383,871		384,843
Accumulated deficit	(544,246)		(438,527)
Accumulated other comprehensive income	3,132		2,489
Total stockholders’ deficiency	(156,980)		(50,941)
Total liabilities and stockholders’ deficiency	$	291,745	$	408,672

The accompanying notes are an integral part of these consolidated financial statements.

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LodgeNet Interactive Corporation and Subsidiaries

Consolidated Statements of Operations (Unaudited)

(Dollar amounts in thousands, except share data)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012		2011
Revenues:
Hospitality and Advertising Services	$	88,247	$	104,199	$	269,583	$	313,423
Healthcare	2,983		2,648		9,127		7,788
Total revenues	91,230		106,847		278,710		321,211

Direct costs and operating expenses:
Direct costs (exclusive of operating expenses and depreciation and amortization shown separately below):
Hospitality and Advertising Services	53,763		58,615		161,672		176,555
Healthcare	1,471		1,421		5,280		3,871
Operating expenses:
System operations	8,311		9,768		25,455		29,569
Selling, general and administrative	8,770		10,326		28,761		30,854
Depreciation and amortization	13,777		17,075		47,018		54,499
Goodwill impairment charge	-		-		92,614		-
Restructuring charge	1,055		732		5,221		1,896
Other operating (income) expense	(4)		31		(37)		9
Total direct costs and operating expenses	87,143		97,968		365,984		297,253

Income (loss) from operations	4,087		8,879		(87,274)		23,958

Other income and (expenses):
Interest expense	(5,799)		(6,379)		(17,651)		(25,012)
Loss on early retirement of debt	-		-		(312)		(158)
Other income (expense)	2		(166)		26		149

(Loss) income before income taxes	(1,710)		2,334		(105,211)		(1,063)
Provision for income taxes	(251)		(290)		(508)		(725)

Net (loss) income	$	(1,961)	$	2,044	$	(105,719)	$	(1,788)

Preferred stock dividends (See Note 14)	$	(1,431)	$	(1,437)	$	(4,294)	$	(4,312)

Net (loss) income attributable to common stockholders	$	(3,392)	$	607	$	(110,013)	$	(6,100)

Net (loss) income per common share (basic)	$	(0.13)	$	0.02	$	(4.35)	$	(0.24)

Net (loss) income per common share (diluted)	$	(0.13)	$	0.02	$	(4.35)	$	(0.24)

Weighted average shares outstanding (basic)	25,398,834		25,209,580		25,268,298		25,061,417

Weighted average shares outstanding (diluted)	25,398,834		25,407,404		25,268,298		25,061,417

The accompanying notes are an integral part of these consolidated financial statements.

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LodgeNet Interactive Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income (Unaudited)

(Dollar amounts in thousands)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012		2011
Net (loss) income	$	(1,961)	$	2,044	$	(105,719)	$	(1,788)
Currency translation adjustment:
Unrealized net change during period	501		(1,107)		643		(642)
Cash flow hedging:
Net gain on interest rate swaps	-		-		-		(89)
Reclassification of net realized loss on interest rate swaps	-		-		-		4,003
Amortization of unrealized loss on interest rate swaps	-		-		-		4,928
Total cash flow hedging	-		-		-		8,842
Other comprehensive income (loss)	501		(1,107)		643		8,200
Comprehensive (loss) income	$	(1,460)	$	937	$	(105,076)	$	6,412

The accompanying notes are an integral part of these consolidated financial statements.

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LodgeNet Interactive Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

(Dollar amounts in thousands)

	Nine Months Ended September 30,
	2012		2011
Operating activities:
Net loss	$	(105,719)	$	(1,788)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	47,018		54,499
Gain on derivative instruments	-		(1,511)
Goodwill impairment charge	92,614		-
Loss on early retirement of debt	312		158
Share-based compensation and restricted stock	1,101		1,192
Deferred tax expense	178		-
Other, net	1,355		461
Change in operating assets and liabilities:
Accounts receivable, net	10,503		2,600
Other current assets	518		831
Accounts payable	13,063		(11,078)
Accrued expenses and deferred revenue	(6,619)		(5,053)
Other	(1,990)		709
Net cash provided by operating activities	52,334		41,020

Investing activities:
Property and equipment additions	(26,732)		(16,712)
Net cash used for investing activities	(26,732)		(16,712)

Financing activities:
Repayment of long-term debt	(39,500)		(8,025)
Payment of capital lease obligations	(456)		(564)
Borrowings on revolving credit facility	62,000		60,000
Repayments of revolving credit facility	(41,000)		(60,000)
Debt issuance costs	-		(2,438)
Proceeds from investment in long-term debt	2,306		469
Payment of dividends to preferred shareholders	(4,295)		(4,312)
Exercise of stock options	10		7
Net cash used for financing activities	(20,935)		(14,863)

Effect of exchange rates on cash	16		(54)
Increase in cash	4,683		9,391
Cash at beginning of period	14,019		8,381

Cash at end of period	$	18,702	$	17,772

The accompanying notes are an integral part of these consolidated financial statements.

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LodgeNet Interactive Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 1 — Basis of Presentation

The accompanying consolidated financial statements as of September 30, 2012, and for the three and nine month periods ended September 30, 2012 and 2011, have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”). The information furnished in the accompanying consolidated financial statements reflects all adjustments, consisting of normal recurring adjustments, which, in our opinion, are necessary for a fair statement of such financial statements.

Certain information and footnote disclosures, normally included in annual financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to the rules and regulations of the Commission. Although we believe the disclosures are adequate to make the information presented herein not misleading, it is recommended these unaudited consolidated financial statements be read in conjunction with the more detailed information contained in our Annual Report on Form 10-K for 2011, as filed with the Commission. The results of operations for the three and nine month periods ended September 30, 2012 and 2011 are not necessarily indicative of the results of operations for the full year due to inherent seasonality within the business, among other factors.

The consolidated financial statements include the accounts of LodgeNet Interactive Corporation and its subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.

The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and the amount of liabilities that might be necessary should we be unable to continue as a going concern. However, during 2012, the Company experienced a significant decrease in total revenue. Although significant declines were experienced in the first six months of 2012, the decline in revenue experienced during the third quarter of 2012 was even greater than what we had previously estimated. At the same time, two of our major vendors required us to enter into payment plans. Therefore, during September 2012, we entered into forbearance agreements with these two major vendors. The decline in revenue during the third quarter of 2012 and the payment terms of our vendor forbearance agreements created liquidity constraints on our operations and related financial results. These liquidity constraints and our non-compliance with certain of our debt covenants have resulted in there being substantial doubt about our ability to continue as a going concern.

Historically, the Company followed a practice of reducing outstanding debt under our Credit Facility by making prepayments on our debt. These additional debt payments contributed to our historical debt covenant compliance. However, during 2012, our practice of making additional debt payments was achieved in part by delaying certain payments to our vendors, including major vendors such as DirecTV and HBO. During the third quarter of 2012, each of these vendors required us to enter into payment plans. In order to maintain continued service from these two vendors, we entered into forbearance agreements with each of them, which require payments to both vendors between September and December 2012. According to the agreements, our next payments of $10.0 million and $4.0 million to DirecTV and HBO, respectively, would have been due on November 15, 2012. We did not expect to have the necessary liquidity to make such payments and maintain our operations. Consequently, we have negotiated a revision to our forbearance agreement with DirecTV, whereby our November payment has been deferred to December 17, 2012, at which time we will be obligated to pay them $20.0 million. We have also negotiated a revision to our forbearance agreement with HBO, whereby we will make a current payment of $1.5 million to them, representing a partial payment of our November obligation, defer the balance to December and owe them a payment of $6.0 million on December 17, 2012. The Company has obtained the consent of the requisite lenders to revise such forbearance agreements. If we are unable to obtain sufficient liquidity to make such payments, which is likely, or such payments are not further deferred, we would be forced to file under Chapter 11 of the U.S. Bankruptcy Code in December. The Company is in active negotiations with its lenders and a potential investor in an effort to structure an orderly bankruptcy process.

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As of September 30, 2012, we were in violation of the leverage covenant in our Credit Facility, as well as certain other non-financial covenants. Effective October 15, 2012, we entered into a Forbearance Agreement and Second Amendment (the “Forbearance Agreement”) to the Credit Facility, as more fully described in Note 6, pursuant to which the lenders have agreed not to exercise their default-related rights and remedies through the period ending December 17, 2012. There is no assurance we can remain in compliance with the Forbearance Agreement or other covenants in the Credit Facility. Consequently, we have classified our outstanding debt obligations, contractually due in April 2014, as current in our consolidated balance sheet as of September 30, 2012, as the lenders could require payment of amounts outstanding under our Credit Facility on December 17, 2012 or at an earlier date if we cannot remain in compliance with the forbearance agreement. If we are unable to refinance or restructure our debt prior to December 17, 2012, as described in the next two paragraphs, or if we are unable to extend our Forbearance Agreement, we would likely be forced to make a filing under Chapter 11.

We are currently engaged in negotiations with a group of lenders and with certain third parties regarding restructuring options, including a potential sale transaction to a third-party that would restructure our existing Credit Facility with a combination of extended maturity dates and a new equity contribution; would involve a change in control of the company; and likely include a filing under Chapter 11.

Our ability to continue as a going concern is dependent upon maintaining adequate liquidity levels and satisfying our vendor obligations, a successful refinancing or restructuring of our existing Credit Facility, or finding alternative financing through a potential sale transaction with a third-party. There can be no assurance that the Company will be successful in refinancing or restructuring, obtaining acceptable alternative financing or maintaining adequate liquidity to satisfy vendor obligations. In the event the Company was to make a Chapter 11 filing, there can be no assurance that the common equity or the preferred equity would have any value. As a result, the common equity might be cancelled without the holders thereof receiving any distribution in a Chapter 11 case, and the preferred equity might also be cancelled without any assurance that the holders thereof would receive any distributions. If the preferred shareholders were to receive a distribution, there can be no assurance as to the value of any such distribution.

Note 2 — Property and Equipment, Net

Property and equipment was comprised as follows (dollar amounts in thousands):

	September 30,		December 31,
	2012		2011
Land, building and equipment	$	111,162	$	114,407
Hotel systems	583,781		610,807
Total	694,943		725,214
Less - depreciation and amortization	(585,333)		(606,050)
Property and equipment, net	$	109,610	$	119,164

Note 3 — Goodwill and Other Intangible Assets

Goodwill represents the excess of cost over the fair value of net assets acquired. In 2007, we recorded goodwill in connection with the acquisitions of StayOnline, On Command and The Hotel Networks. The product lines of both StayOnline and On Command shared the same operating and economic characteristics as our pre-acquisition product lines, and were integrated into the Hospitality operating segment.

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Per Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, “Intangibles – Goodwill and Other,” our goodwill is not amortized; rather, it is tested for impairment annually or if there is a triggering event which indicates the carrying value may not be recoverable. An entity may first assess qualitative factors to evaluate if the existence of events or circumstances leads to a determination it is necessary to perform the current two-step goodwill impairment test. After assessing the totality of events or circumstances, if it is determined it is more likely than not the fair value of a reporting unit is less than its carrying amount, then the two-step impairment test must be performed for that reporting unit or units. An entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to the two-step impairment test, and then resume performing the qualitative assessment in any subsequent period. If an entity determines it is necessary to perform the two-step test, the first step is to compare a reporting unit’s fair value to its carrying amount. If the carrying amount is positive and does not exceed the reporting unit’s fair value, no impairment loss exists. If the carrying amount exceeds the reporting unit’s fair value, the second step (Step 2) is to be performed. Reporting units with zero or negative carrying amounts are required to perform Step 2 of the goodwill impairment test if it is more likely than not goodwill impairment exists. In considering whether it is more likely than not that an impairment loss exists, we evaluate qualitative factors, including the same factors which would trigger an interim impairment test of goodwill. Factors include a significant deterioration in market conditions, unanticipated competition, a significant decline in revenue and margin or an anticipated sale of a reporting unit. If an entity determines it is more likely than not that an impairment exists, Step 2 of the impairment test must be performed for that reporting unit or units. Step 2 involves allocating the fair value of the reporting unit to each asset and liability, with the excess being implied goodwill. An impairment loss results if the amount of recorded goodwill exceeds the implied goodwill.

The declines in Guest Entertainment revenue and in our room base during 2012 have occurred at a rate greater than what we previously estimated. In addition, our market capitalization declined during the first half of 2012. The declines in Guest Entertainment revenue and room base during the first half of 2012 caused the Company to reassess and update our financial plans to reflect these changes in our Hospitality business. These matters were qualitative factors impacting the recovery of our Hospitality reporting unit goodwill, and triggered an assessment of goodwill on an interim basis during the second quarter of 2012. As of June 30, 2012, our Hospitality reporting unit had a negative carrying value of $(85.7) million. As such, we evaluated the qualitative factors and determined it was more likely than not that an impairment existed. In Step 2 of our impairment testing, it was determined the estimated fair value of the assets and liabilities of the Hospitality reporting unit exceeded the fair value of the reporting unit, resulting in no implied goodwill. As a result of our second quarter 2012 impairment test, we recorded a non-cash asset impairment charge in our Hospitality segment of $92.6 million related to goodwill.

The carrying amount of goodwill by reportable segment was as follows (dollar amounts in thousands):

			Advertising
	Hospitality		Services		Total
Balance as of December 31, 2011
Goodwill	$	92,614	$	18,679	$	111,293
Accumulated impairment losses	-		(11,212)		(11,212)
	92,614		7,467		100,081
Activity during the period - Impairment charge	(92,614)		-		(92,614)

Balance as of September 30, 2012
Goodwill	92,614		18,679		111,293
Accumulated impairment losses	(92,614)		(11,212)		(103,826)
	$	-	$	7,467	$	7,467

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We have intangible assets consisting of certain acquired technology, patents, trademarks, hotel contracts, customer relationships, studio agreements and licensee fees. These intangible assets have been deemed to have finite useful lives and are amortized over their current estimated useful lives, ranging from 2 to 20 years. We review the intangible assets for impairment when triggering events occur or a change in circumstances, such as a significant deterioration in market conditions, warrant modifications to the carrying amount of the assets. We have concluded that our liquidity constraints as more fully described in Note 1 and Note 6 have not resulted in any intangible asset impairments as of September 30, 2012.

We had the following intangible assets (dollar amounts in thousands):

	September 30, 2012				December 31, 2011
	Carrying		Accumulated		Carrying		Accumulated
	Amount		Amortization		Amount		Amortization
Assets subject to amortization:
Acquired contracts and relationships	$	116,915	$	(32,822)	$	120,315	$	(30,237)
Other acquired intangibles	12,101		(11,797)		13,988		(13,273)
Tradenames	3,024		(2,608)		3,145		(2,508)
Acquired patents	5,219		(5,044)		5,216		(5,004)
	$	137,259	$	(52,271)	$	142,664	$	(51,022)

We recorded amortization expense of $6.7 million and $5.6 million, respectively, for the nine months ended September 30, 2012 and 2011. During the three months ended September 30, 2012 and 2011, we recorded amortization expense of $1.6 million and $1.8 million, respectively. During the second quarter of 2012, due to changes in our broadband business, including continued room loss, we recorded a $1.4 million non-cash asset impairment charge related to intangible assets. We estimate total amortization expense for the three months remaining in 2012 and the years ending December 31 as follows (dollar amounts in millions): 2012 - $1.6; 2013 - $6.1; 2014 - $6.0; 2015 - $6.0; 2016 - $5.9 and 2017 - $5.9. Actual amounts may change from such estimated amounts due to additional intangible asset acquisitions, potential impairment, accelerated amortization or other events.

Note 4 — Earnings Per Share Computation

We follow FASB ASC Topic 260, “Earnings Per Share,” which requires the computation and disclosure of two earnings per share (“EPS”) amounts, basic and diluted. Basic EPS is computed based on the weighted average number of common shares actually outstanding during the period. Diluted EPS is computed based on the weighted average number of common shares outstanding plus all potentially dilutive common shares outstanding during the period. Potential common shares which have an anti-dilutive effect are excluded from diluted earnings per share. The provisions of FASB ASC Topic 260 also provide that unvested share-based payment awards which contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. We determined our outstanding shares of non-vested restricted stock are participating securities.

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The following table reflects the calculation of weighted average basic and fully diluted shares for the periods ended September 30. Dollar amounts are in thousands, except share data:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011
Basic EPS:
Net income (loss)	$	(1,961)	$	2,044	$	(105,719)	$	(1,788)
Preferred stock dividends (See Note 14)	(1,431)		(1,437)		(4,294)		(4,312)
	(3,392)		607		(110,013)		(6,100)
Income (loss) allocated to participating securities (1)	-		3		-		-
Net income (loss) available to common stockholders	$	(3,392)	$	604	$	(110,013)	$	(6,100)

Weighted average shares outstanding for basic earnings per common share	25,398,834		25,209,580		25,268,298		25,061,417
Basic earnings per share	$	(0.13)	$	0.02	$	(4.35)	$	(0.24)

Diluted EPS:
Net income (loss)	$	(1,961)	$	2,044	$	(105,719)	$	(1,788)
Preferred stock dividends (See Note 14)	(1,431)		(1,437)		(4,294)		(4,312)
	(3,392)		607		(110,013)		(6,100)
Income (loss) allocated to participating securities (1)	-		3		-		-
Net income (loss) available to common stockholders	$	(3,392)	$	604	$	(110,013)	$	(6,100)

Weighted average shares outstanding for basic earnings per common share	25,398,834		25,209,580		25,268,298		25,061,417
Dilutive effect of potential shares (2)	N/A		197,824		N/A		N/A
Weighted average shares outstanding for diluted earnings per common share	25,398,834		25,407,404		25,268,298		25,061,417
Diluted earnings per share	$	(0.13)	$	0.02	$	(4.35)	$	(0.24)

Participating securities (1)	758,475		-		758,475		126,625

Potential dilutive common shares (2)	18,270,488		17,061,292		18,270,488		17,187,917

(1) For the three months ended September 30, 2012 and the nine months ended September 30, 2012 and 2011, participating securities, which do not participate in losses, were not included in the calculations of earnings per share, as we were in a loss position and their inclusion would have been anti-dilutive.

(2) For the three months ended September 30, 2012 and the nine months ended September 30, 2012 and 2011, potential dilutive common shares, which include stock options, unvested restricted stock, warrants and the conversion of preferred stock, were not included in the computation of diluted earnings per share, as we were in a loss position and their inclusion would have been anti-dilutive. For the three months ended September 30, 2011, the conversion of preferred stock was not included, as its inclusion would have been anti-dilutive. In addition, stock options, unvested restricted stock and warrants with exercise prices greater than the average market price of our common stock were not included in the computation of diluted earnings per share, as their inclusion would have been anti-dilutive.

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Note 5 — Accrued Expenses

Accrued expenses were comprised as follows (dollar amounts in thousands):

	September 30,		December 31,
	2012		2011
Property, sales and other taxes	$	4,432	$	5,369
Compensation	2,794		5,275
Interest	685		778
Programming related	2,209		958
Restructuring and reorganization	713		80
Preferred stock dividends	-		1,432
Purchase commitments	1,601		2,786
Other	2,698		2,135
	$	15,132	$	18,813

Note 6 — Long-term Debt and Credit Facilities

Long-term debt was comprised as follows (dollar amounts in thousands):

	September 30,		December 31,
	2012		2011
Credit Facility:
Term loan	$	325,407	$	362,601
Revolving loan commitment	21,000		-
Capital leases	979		699
	347,386		363,300
Less current maturities	(346,741)		(10,395)
	$	645	$	352,905

Credit Facility ¾ In April 2007, we entered into a $675.0 million Credit Facility, comprised of a $625.0 million term loan, which matures in April 2014, and a $50.0 million revolving loan commitment, which matures in April 2013. The term loan originally required quarterly repayments of $1,562,500, which began September 30, 2007. The term loan originally bore interest at our option of (1) the bank’s base rate plus a margin of 1.0% or (2) LIBOR plus a margin of 2.0%. Our obligations under the Credit Facility are collateralized by a pledge of substantially all of the assets of the Company.

Effective March 22, 2011, we entered into a First Amendment (the “First Amendment”) to the Credit Facility. The First Amendment modified certain terms of the Credit Facility, including an increase in the permitted consolidated leverage ratio, the creation of a specific preferred stock dividend payment basket and the potential to extend the term beyond its current expiration in April 2014 at the lenders’ option. The restricted payment basket within the First Amendment allows for dividend payments not to exceed $5,750,000 per year. In 2011, the Company incurred $2.7 million of debt issuance costs related to certain fees and expenses in connection with this First Amendment.

Under the First Amendment, the $50.0 million revolving loan commitment was reduced to $25.0 million. The First Amendment also requires us to make quarterly term loan repayments of $2.5 million, which began June 30, 2011, through December 31, 2012, and $3.75 million beginning March 31, 2013 through December 31, 2013. The amended term loan and revolving loan commitment bear interest at our option of (1) the bank’s base rate plus a margin of 4.0% or (2) LIBOR plus a margin of 5.0%. In addition, a LIBOR floor of 1.5% was established under the First Amendment.

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As discussed in Note 1, our inability to comply with the financial covenants under the Credit Facility, uncertainty over our ability to remain in compliance with these covenants, the lenders’ ability to require payment on the debt on December 17, 2012, and our liquidity constraints, have raised substantial doubt about our ability to meet our ongoing financial obligations. We are experiencing significant liquidity constraints and our ability to continue as a going concern is dependent upon maintaining adequate liquidity levels and satisfying our vendor obligations, a successful refinancing or restructuring of our existing Credit Facility, or finding alternative financing through a potential sale transaction with a third-party. There can be no assurance that the Company will be successful in achieving such refinancing or restructuring, obtaining acceptable alternative financing or maintaining adequate liquidity to satisfy vendor obligations. Consequently, the Company is exploring all other options available including filing under Chapter 11. In the event the Company was to make such a filing, there can be no assurance that the common equity or the preferred equity would have any value. As a result, the common equity might be cancelled without the holders thereof receiving any distribution in a Chapter 11 case, and the preferred equity might also be cancelled without any assurance that the holders thereof would receive any distributions. If the preferred shareholders were to receive a distribution, there can be no assurance as to the value of any such distribution.

We are currently engaged in negotiations with a group of lenders and with certain third parties regarding restructuring options, including a potential sale transaction with a third party that would restructure our existing Credit Facility with a combination of extended maturity dates and a new equity contribution which would involve a change in control of the Company, and likely would include a filing under Chapter 11. As described above, we have entered into a Forbearance Agreement with the participating lenders in the Credit Facility which provides that the lenders will refrain from exercising certain of their default-related rights and remedies throughout the period ending December 17, 2012. If we are not able to enter into such a potential sale transaction, it is unlikely we could regain compliance with our current debt covenants and comply with the terms of our Forbearance Agreement, and if our lenders do not agree to amend or waive covenants with which we are not in compliance, the debt would be due and payable, we would not be able to satisfy our financial obligations and we would likely be forced to file under Chapter 11.

During the first quarter of 2012, we made a prepayment of $15.0 million on the term loan, along with the required payment of $2.5 million. We expensed $156,000 of debt issuance costs related to the prepayment. During the second quarter of 2012, we prepaid $17.0 million on the term loan and made our required quarterly payment of $2.5 million. We expensed $156,000 of debt issuance costs. During the third quarter of 2012, we made our required quarterly payment of $2.5 million.

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In the first quarter of 2011, we made our required quarterly payment of $1.0 million and prepaid $2.0 million on the term loan. We expensed $158,000 of debt issuance costs related to the prepayment and the First Amendment described above. During the second and third quarters of 2011, we made the required payments of $2.5 million per quarter.

The Credit Facility originally provided for the issuance of letters of credit up to $15.0 million, subject to customary terms and conditions. Under the terms of the First Amendment, this amount was reduced to $7.5 million. As of September 30, 2012, we had outstanding letters of credit totaling $350,000, which reduces amounts available under the revolving loan commitment. The lenders are not required to permit the issuance of additional letters of credit under the Credit Facility pursuant to the terms of the Forbearance Agreement. During the third quarter of 2012, we borrowed $37.0 million under the revolving loan commitment and repaid $16.0 million during the quarter. The revolving loan commitment will expire in April 2013. If we are not able to secure alternative financing, this would have a substantial adverse impact on the Company and our ability to continue our operations.

The Credit Facility also requires we notify the lenders upon the occurrence of any development or event that has had or could reasonably be expected to have a “Material Adverse Effect” prior to any draw on the Company’s revolving loan commitment, as such terms are defined and used within our Credit Facility. While under the Credit Facility the occurrence of a development or event that has had or could reasonably be expected to have a Material Adverse Effect is not, in and of itself, an event of default, nevertheless if such an event occurred, it could restrict the Company’s ability to obtain additional financing under the revolving loan commitment. At September 30, 2012, we had fully drawn down the amounts available to us under our revolving loan commitment. The term loan and revolver interest rates during the quarter ended September 30, 2012 were 6.5% and 7.25%, respectively. The weighted average interest rate for the quarter ended September 30, 2012 was 6.6%. Effective September 30, 2012, under the Forbearance Agreement the term loan and revolver will bear an additional 2.0% margin for total interest rates of 8.5% and 9.25%, respectively. As of September 30, 2012, we were not in compliance with all financial covenants required by our Credit Facility, as noted above.

Capital Leases — As of September 30, 2012, we had total capital lease obligations of $1.0 million. We acquired approximately $729,000 of equipment under capital lease arrangements during the nine months ended September 30, 2012. Our capital lease obligations consist primarily of vehicles used in our field service operations.

As of September 30, 2012, long-term debt had the following scheduled maturities for the three months remaining in 2012 and the full years ending December 31, 2013 and after (dollar amounts in thousands):

	2012		2013		2014		2015		2016
Long-term debt	$	346,407	$	-	$	-	$	-	$	-
Capital leases	105		328		284		249		51
	346,512		328		284		249		51
Less amount representing interest on capital leases	(7)		(17)		(10)		(4)		-
	$	346,505	$	311	$	274	$	245	$	51

As a result of our non-compliance with our debt covenants, combined with uncertainty over our ability to remain in compliance with these covenants, and the lenders’ ability to require payment of amounts outstanding under our Credit Facility on December 17, 2012, we have classified our outstanding debt obligations, contractually due in April 2014, as current in our consolidated balance sheet as of September 30, 2012.

We do not utilize special purpose entities or off-balance sheet financial arrangements.

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Note 7 ¾ Comprehensive Income

FASB ASC Topic 220, “Comprehensive Income,” provides standards for reporting and disclosure of comprehensive income and its components. Comprehensive income reflects the changes in equity during a period from transactions related to our foreign currency translation adjustments for the periods ended September 30, 2012 and 2011, and our interest rate swap arrangements for the period ended September 30, 2011.

Accumulated other comprehensive income, as shown on our Consolidated Balance Sheets, consisted of foreign currency translation adjustments as of September 30, 2012 and December 31, 2011.

Note 8 ¾ Statements of Cash Flows

Cash is comprised of demand deposits. Cash paid for interest was $17.7 million and $26.1 million, respectively, for the nine months ended September 30, 2012 and 2011. Cash paid for taxes was $0.3 million and $0.6 million for the nine months ended September 30, 2012 and 2011, respectively.

Note 9 — Share-Based Compensation

We account for our stock option and incentive plans under the recognition and measurement provisions of FASB ASC Topic 718, “Compensation – Stock Compensation,” which require the measurement and recognition of compensation expense for all stock-based awards based on estimated fair values, net of estimated forfeitures. Share-based compensation expense recognized in the three and nine months ended September 30, 2012 and 2011 includes compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of this Topic.

The following amounts were recognized in our Consolidated Statements of Operations for share-based compensation plans for the periods ended September 30 (dollar amounts in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011
Compensation cost:
Stock options	$	97	$	233	$	460	$	812
Restricted stock	104		91		641		380
Total share-based compensation expense	$	201	$	324	$	1,101	$	1,192

For the nine months ended September 30, 2012 and 2011, cash received from stock option exercises was $10,000 and $7,000, respectively. Due to our net operating loss tax position, we did not recognize a tax benefit from options exercised under the share-based payment arrangements. The amounts presented in the table above are included as non-cash compensation in our cash flow from operating activities.

Stock Options

For the three months ended September 30, 2012, we did not grant any stock options to non-employee directors of the Company; however, we did grant 550,000 stock options to officers and employees. The valuation methodology used to determine the fair value of the options issued during the quarter was the Black-Scholes-Merton option-pricing model. The Black-Scholes-Merton model requires the use of exercise behavior data and the use of a number of assumptions, including volatility of the stock price, the weighted average risk-free interest rate and the weighted average expected life of the options. We do not pay dividends on our common stock; therefore, the dividend rate variable in the Black-Scholes-Merton model is zero.

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Restricted Stock

For the three months ended September 30, 2012, we did not award any shares of time-based restricted stock to our non-employee directors; however, we did award 550,000 shares of time-based restricted stock to our CEO pursuant to our 2012 CEO Equity Incentive Plan, however, the restricted stock grant was rescinded on October 19, 2012. The fair value of the restricted stock was equal to the fair market value, as defined by the terms of the 2012 Plan, on the date of grant and would have amortized ratably over the vesting period. In the third quarter of 2012, we did not issue any performance-based restricted stock.

Note 10 — Restructuring

In 2012, we implemented reorganization initiatives to gain operating efficiencies by reducing the number of service operation locations and reorganizing departments and management structure. These initiatives included a reduction in workforce, by approximately 11%, and vacating leased warehouse/office facilities. As a result of these actions and executive restructuring, we incurred $1.1 million of costs during the three months ended September 30, 2012 and $5.2 million of costs during the nine months ended September 30, 2012, related to our Hospitality and Advertising Services businesses. As a result of our 2011 restructuring initiative, we incurred $0.7 million of costs during the three months ended September 30, 2011 and $1.9 million of costs during the nine months ended September 30, 2011. All such costs are included in operating expenses on the Consolidated Statements of Operations.

We estimate additional expenses charged to restructuring over the next twelve to eighteen months, primarily related to the initiatives noted above, will be in the range of $0.5 million to $1.0 million. Additional accruals and cash payments related to the restructuring activities are dependent upon reduction in force or subleasing arrangements, which could change our expense estimates.

Liabilities associated with our restructuring activities to date, along with charges to expense and cash payments, were as follows (dollar amounts in thousands):

	Severance and other benefit related costs		Cost of closing redundant acquired facilities		Asset impairment		Total
December 31, 2011 balance	$	40	$	40	$	-	$	80
Charges to expense	4,771		236		214		5,221
Cash payments/utilization	(4,270)		(104)		(214)		(4,588)
September 30, 2012 balance	$	541	$	172	$	-	$	713

Note 11 — Fair Value Measurements

We follow the fair value measurement and disclosure provisions of FASB ASC Topic 820, “Fair Value Measurements and Disclosures,” relating to financial and nonfinancial assets and liabilities. The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. FASB ASC Topic 820 includes a fair value hierarchy, which is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques, which are used to measure fair value and which are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources, while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions. The fair value hierarchy consists of the following three levels:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

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Financial Assets and Financial Liabilities ¾ The estimated carrying and fair values of our financial instruments in the financial statements were as follows (dollar amounts in thousands):

	September 30, 2012				December 31, 2011
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Long-term debt	$	347,386	$	266,034	$	363,300	$	319,788

The fair value of our long-term debt is classified as Level 2 and is estimated based on current interest rates for similar debt of the same remaining maturities and quoted market prices, except for capital leases and our revolving loan commitment borrowings, which are reported at carrying value. For our capital leases and revolving loan commitment borrowings, the carrying value approximates the fair value. The fair value of our long-term debt is strictly hypothetical and not indicative of what we are required to pay under the terms of our debt instruments. See Note 6 to the Consolidated Financial Statements for further disclosures regarding long-term debt and our Credit Facility.

Nonfinancial Assets and Nonfinancial Liabilities ¾ Certain assets and liabilities measured at fair value on a non-recurring basis could include nonfinancial assets and nonfinancial liabilities measured at fair value in the goodwill impairment tests and intangible assets and other nonfinancial long-lived assets measured at fair value for impairment assessment. The fair value of our goodwill and intangible assets are determined based on valuation techniques using the income approach, utilizing a discounted cash flow analysis based on key assumptions and estimates. Accordingly, the fair values of our goodwill and intangible assets are classified as Level 3.

Note 12 — Segment Information

We operate in three reportable segments, Hospitality, Advertising Services and Healthcare. We organize and manage our segments based upon the products and services delivered and the nature of our customer base receiving those products and services. The Hospitality business distributes entertainment, media and connectivity services to the hospitality industry. Our Advertising Services business generates revenue from the sale of advertising-based media services within our hospitality customer base, utilizing the same server-based technology or by satellite transmission. Our Healthcare business generates revenue from the sale of interactive system hardware, software licenses, installation services and related programming and support agreements to the healthcare market.

Our Hospitality and Advertising Services businesses provide a variety of interactive and media network services to hotels and/or the respective hotels’ guests. The products can include interactive video-on-demand programming, music, games, cable television programming, Internet services or advertising services, and have an analogous consumer base. All products and services are delivered through a proprietary system platform utilizing satellite delivery technology, and are geared towards the hotels and their guests.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies, except certain expenses are not allocated to the segments. These unallocated expenses are corporate overhead, depreciation and amortization expenses, restructuring charges, other operating income (expense), interest expense, loss on the early retirement of debt, other income (expense) and income tax expense. The goodwill impairment charge is attributable to our Hospitality segment. We evaluate segment performance based upon operating profit and loss before the aforementioned expenses.

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Financial information related to our reportable segments for the three and nine months ended September 30 was as follows (dollar amounts in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011
Total revenues:
Hospitality	$	86,768	$	101,833	$	265,370	$	306,259
Advertising Services	1,479		2,366		4,213		7,164
Healthcare	2,983		2,648		9,127		7,788
Total	$	91,230	$	106,847	$	278,710	$	321,211

Operating profit:
Hospitality	$	22,205	$	31,049	$	68,561	$	92,506
Advertising Services	778		430		1,736		1,170
Healthcare	794		439		1,251		1,827
Operating profit	23,777		31,918		71,548		95,503

Corporate	(4,862)		(5,201)		(14,006)		(15,141)
Depreciation and amortization	(13,777)		(17,075)		(47,018)		(54,499)
Goodwill impairment charge	-		-		(92,614)		-
Restructuring charge	(1,055)		(732)		(5,221)		(1,896)
Other operating income (expense)	4		(31)		37		(9)
Interest expense	(5,799)		(6,379)		(17,651)		(25,012)
Loss on early retirement of debt	-		-		(312)		(158)
Other income (expense)	2		(166)		26		149
Income (loss) before income taxes	$	(1,710)	$	2,334	$	(105,211)	$	(1,063)

Note 13 — Derivative Information

We follow the provisions of FASB ASC Topic 815, “Derivatives and Hedging Activities,” which establish accounting and disclosure standards regarding a company’s derivative instruments and hedging activities.

We were required by our original Credit Facility to convert 50% of the outstanding term loan into a fixed interest rate for a period not less than two years. Our objective of entering into hedge transactions (or interest rate swaps) using derivative financial instruments was to reduce the variability of cash flows associated with variable-rate loans and comply with the terms of our Credit Facility. As changes in interest rates impact future interest payments, the hedges provided an offset to the rate changes. The swap agreements expired in June 2011. The First Amendment to our Credit Facility did not require us to enter into any hedge agreements.

In April 2007, we entered into interest rate swap agreements with notional values of $312.5 million, at a fixed rate of 5.09%, and $125.0 million, at a fixed rate of 4.97%, both of which expired in June 2011. These swap arrangements effectively changed the underlying debt from a variable interest rate to a fixed interest rate for the term of the swap agreements. All of the swap agreements were issued by Credit Suisse International. The swap agreements were designated as, and met the criteria for, cash flow hedges and were not considered speculative in nature.

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With our amended Credit Facility, our interest rate swaps ceased to be effective and hedge accounting was discontinued effective March 22, 2011 and going forward, primarily related to the LIBOR floor of 1.5% as established under the First Amendment. As a result, our deferred losses of $4,928,000 recorded in other comprehensive income were frozen and were amortized into earnings over the original remaining term of the hedged transaction. All subsequent changes in the fair value of the swaps were recorded directly to interest expense. For the nine months ended September 30, 2011, we recorded a loss of $4,928,000 related to amortization of our deferred losses and a gain of $6,439,000 related to the change in fair value of the interest rate swaps. The net amount of $1,511,000 is a non-cash gain and did not impact the amount of cash interest paid during the period.

A summary of the effect of cash flow hedges on our financial statements for the nine months ended September 30, 2011 was as follows (dollar amounts in thousands):

Effective Portion

Income Statement

Location of

Amount of

Swap Interest

Gain (Loss)

Reclassified From

Recognized

Accumulated

Ineffective Portion

in Other

Other

Income

Type of Cash

Comprehensive

Statement

Amount

Flow Hedge

Income

Location

Recognized

Nine Months Ended September 30, 2011:

Interest rate swaps

Interest expense

4,672

Interest expense

(1,511)

Note 14 ¾ Perpetual Preferred Stock Dividend

Subject to the declaration of dividends by our Board of Directors, cumulative dividends on the preferred stock will be paid at a rate of 10% per annum of the $1,000 liquidation preference per share, starting from the date of original issue, June 29, 2009. Dividends accumulate quarterly in arrears on each January 15, April 15, July 15 and October 15, beginning on October 15, 2009. Dividend payments not to exceed $5,750,000 in any fiscal year are allowable under the restricted payment basket as defined within the First Amendment to our Credit Facility.

The payment of dividends on our preferred stock requires our Board of Directors to declare such dividend payable. Our Board of Directors has determined not to declare a dividend with respect to the three months ended September 30, 2012. Accordingly, we have not recorded the preferred stock dividends for such period. However, the preferred stock dividends have been included in our earnings per share computation (see Note 4) for the three and nine months ended September 30, 2012 pursuant to ASC 260-10-45-11. The amount in arrears is also included in preferred stock dividends on the Consolidated Statements of Operations for the three and nine months ended September 30, 2012. The deferred dividend of $1.4 million will accumulate in accordance with the terms of the preferred stock and, as of September 30, 2012, the total arrearage on the preferred stock was $1.4 million.

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Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our Consolidated Financial Statements, including the notes thereto, appearing elsewhere herein.

Special Note Regarding Forward-Looking Statements

Certain statements in this report or documents incorporated herein by reference constitute “forward-looking statements.” When used in this report, the words “intends,” “expects,” “anticipates,” “estimates,” “believes,” “goal,” “no assurance” and similar expressions, and statements which are made in the future tense or refer to future events or developments, are intended to identify such forward-looking statements. Such forward-looking statements are subject to risks, uncertainties and other factors which could cause the actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. In addition to the risks and uncertainties discussed elsewhere in this Report and in Item 1A of our most recent Annual Report on Form 10-K for the year ended December 31, 2011 and filed on March 15, 2012, in any prospectus supplement or any report or document incorporated herein by reference, such factors include, among others, the following:

Ø our ability to remain in compliance with the terms of our agreements with our lenders;

Ø our ability to make timely payments to our vendors, as required by our forbearance agreements and our agreements with them (as described below);

Ø our ability to successfully refinance our outstanding debt or restructure the Company;

Ø our ability to continue as a going concern;

Ø our ability to maintain adequate liquidity levels; and

Ø other factors detailed, from time to time, in our filings with the Securities and Exchange Commission.

These forward-looking statements speak only as of the date of this report. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

Executive Overview

During 2012, the Company experienced a significant decrease in total revenue, driven by a major decline in its Guest Entertainment revenue and room base. The declines in Guest Entertainment revenue and in our room base during 2012 have occurred at a rate greater than what we previously estimated. Although significant declines were experienced in the first six months of 2012, the decline in revenue experienced during the third quarter of 2012 was even greater than what we had previously estimated. At the same time, two of our major vendors required us to enter into payment plans. Therefore, during September 2012, we entered into forbearance agreements with these two major vendors. The decline in revenue during the third quarter of 2012 and the payment terms of our vendor forbearance agreements created considerable liquidity constraints to our operations and related financial results during the third quarter of 2012. These liquidity constraints and our non-compliance with certain of our debt covenants have resulted in there being substantial doubt about our ability to continue as a going concern. Our third quarter results are as follows:

In the third quarter, the Company experienced a 14.6% decrease in total revenue, to $91.2 million for the third quarter of 2012, a decrease of $15.6 million compared to the third quarter of 2011. The decrease was primarily due to an 11.6% decline in the average number of Guest Entertainment rooms served and also by a 4.2% decline in Hospitality and Advertising Services revenue per room. Guest Entertainment revenue per room decreased 13.9% quarter over quarter, while revenue generated from non-Guest Entertainment services increased 7.4%. Revenue generated from non-Guest Entertainment services comprised 52.7% of total revenue for the current quarter.

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Liquidity and Capital Resources

At September 30, 2012, we were in violation of the leverage covenant in our Credit Facility. Our leverage and interest coverage ratios were as follows for the periods ended September 30:

	2012	2011

Actual consolidated leverage ratio (1) (3)	4.52	3.50
Maximum per covenant	4.00	4.00

Actual consolidated interest coverage ratio (2) (3)	2.60	2.69
Minimum per covenant	2.25	2.25

(1) Our maximum consolidated leverage ratio is the total amount of all indebtedness of the Company, determined on a consolidated basis in accordance with GAAP, divided by operating income exclusive of depreciation and amortization and adjusted (plus or minus) for certain other miscellaneous cash items, non-cash items and non-recurring items, as defined by the terms of the Credit Facility and the First Amendment.

(2) Our minimum consolidated interest coverage ratio is a function of operating income exclusive of depreciation and amortization and adjusted (plus or minus) for certain other miscellaneous cash items, non-cash items and

non-recurring items divided by interest expense and preferred dividends, as defined by the terms of the Credit Facility and the First Amendment.

(3) Maximum consolidated leverage ratio and minimum consolidated interest coverage ratios are defined terms of the Credit Facility and the First Amendment.

Effective October 15, 2012, we entered into a Forbearance Agreement and Second Amendment to the Credit Facility. Under the terms of the Forbearance Agreement, the lenders agreed to forbear from exercising their respective default-related rights and remedies under the Credit Facility until the earlier of December 17, 2012, or the occurrence of further defaults under the Credit Facility. The principal and interest due under the Credit Facility on September 30, 2012, were paid. However, as a result of our non-compliance with our leverage covenant, combined with uncertainty over our ability to regain compliance with this covenant, as well as other, non-financial covenants, and the ability of the lenders to require payment of amounts outstanding under our Credit facility on December 17, 2012, we have classified our outstanding debt obligations, contractually due in April 2014, as current in our consolidated balance sheet as of September 30, 2012.

In consideration of the forbearance, we agreed to certain additional terms and conditions, including the following: (a) the retention of a strategic planning officer, (b) the provision of certain specific information regarding the Company and required management conference calls and meetings, as well as monthly and weekly reports, (c) the elimination of certain available baskets for incurring debt, disposing of property, and making investments, and a limitation of $5,000,000 on indebtedness outstanding and secured by permitted liens to finance the acquisition of fixed or capital assets, (d) the limitation on making capital expenditures to only those made in the ordinary course and not in excess of $10.5 million annually, and (e) the requirement that the Company maintain Consolidated EBITDA of at least $4,543,000 for the period beginning October 1, 2012 and ending October 31, 2012 and Consolidated EBITDA of at least $8,701,000 for the period beginning October 1, 2012 and ending November 30, 2012. There is no assurance that we will be able to achieve these EBITDA targets. In addition, the Forbearance Agreement adjusts certain other covenants and definitions of the Credit Agreement. The Company is also required to pay certain fees and expenses in connection with the Forbearance Agreement. If we default under the Forbearance Agreement, or under any other provision of the Credit Facility, the Forbearance Agreement will terminate and our lenders will have the ability to accelerate the maturity of the entire principal amount of the indebtedness owed to them. If such an event were to occur, we would not be able to satisfy our financial obligations.

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During the first nine months of 2012, cash provided by operating activities was $52.3 million. Excluding the cash contribution from increased accounts payable, cash provided by operating activities would have been $39.3 million. The Company used $26.7 million of the cash we generated for property and equipment additions. During the same period, we prepaid $32.0 million against our Credit Facility, in addition to the required payments totaling $7.5 million. We also used $4.3 million for preferred stock dividends. During the first nine months of 2011, cash provided by operating activities was $41.0 million. Excluding the negative impact from accounts payable, cash provided by operating activities would have been $52.1 million, and we used cash for property and equipment additions of $16.7 million. During the same period, we prepaid $2.0 million against our Credit Facility, in addition to the required payments totaling $6.0 million. We also used $4.3 million for the preferred stock dividend payments. Cash as of September 30, 2012 was $18.7 million versus $14.0 million as of December 31, 2011.

During the third quarter of 2012, the Company began to experience significant liquidity constraints. Our cash provided by operating activities declined $12.4 million to $1.0 million compared to $13.4 million in the third quarter of 2011, resulting in negative cash flow (see table below) for the quarter. On October 15, 2012 the Company announced that it was neither declaring nor paying the $1.4 million preferred stock dividend.

Special Note Regarding the Use of Non-GAAP Financial Information

To supplement our consolidated financial statements presented in accordance with accounting principles generally accepted in the United States (“GAAP”), we use free cash flow, a non-GAAP measure derived from results based on GAAP. The presentation of this additional information is not meant to be considered superior to, in isolation of or as a substitute for results prepared in accordance with GAAP.

We define free cash flow, a non-GAAP measure, as cash provided by operating activities less cash used for certain investing activities. Free cash flow is a key liquidity measure, but should not be construed as an alternative to cash flows from operating activities or as a measure of our profitability or performance. We provide information about free cash flow because we believe it is a useful way for us, and our investors, to measure our ability to satisfy cash needs, including interest payments on our debt, taxes and capital expenditures. GAAP requires us to provide information about cash flow generated from operations. Our definition of free cash flow does not take into account our debt service requirements or other commitments. Accordingly, free cash flow is not necessarily indicative of amounts of cash which may be available to us for discretionary purposes. Our method of computing free cash flow may not be comparable to other similarly titled measures of other companies.

Free Cash Flow

We manage our free cash flow by seeking to maximize the amount of cash we generate from our operations and managing the level of our investment activity. In addition, we can manage capital expenditures by varying the number of rooms we install in any given period.

Levels of free cash flow are set forth in the following table (dollar amounts in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011
Cash provided by operating activities	$	956	$	13,406	$	52,334	$	41,020
Property and equipment additions	(6,651)		(6,117)		(26,732)		(16,712)
	$	(5,695)	$	7,289	$	25,602	$	24,308

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The Company’s increasing liquidity challenges have been a result of several business trends and debt servicing issues that have negatively impacted our liquidity position. During 2012, the Company experienced a significant decrease in total revenue. The rate of decline in our movie revenue per room for 2011 was approximately 6% versus 2010. The decline accelerated in 2012 and the year-to-date rate of decline has more than doubled to approximately 13% versus the prior year. Although significant declines were experienced in the first six months of 2012, the decline in revenue experienced during the third quarter of 2012 was greater than what we had previously estimated. At the same time, two of our major vendors required us to enter into payment plans. Therefore, during September 2012, we entered into forbearance agreements with two of our major vendors. The decline in revenue during the third quarter of 2012 and the payment terms of our vendor forbearance agreements created liquidity constraints on our operations and related financial results. The decrease in revenue resulted primarily from an 11.9% reduction in the average number of Guest Entertainment rooms served and a 12.9% decline in Guest Entertainment revenue per room.

Historically, the Company followed a practice of reducing outstanding debt under our Credit Facility by making prepayments on our debt. These additional debt payments contributed to our historical debt covenant compliance. However, during 2012, our practice of making additional debt payments was achieved in part by delaying certain payments to our vendors, including major vendors such as DirecTV and HBO. During the third quarter of 2012, each of these vendors required us to enter into payment plans. In order to maintain continued service from these two vendors, we entered into forbearance agreements with each of them which require payments to both vendors between September and December 2012. According to the agreements, our next payments of $10.0 million and $4.0 million to DirecTV and HBO, respectively, would have been due on November 15, 2012. We did not expect to have the necessary liquidity to make such payments and maintain our operations. Consequently, we have negotiated a revision to our forbearance agreement with DirecTV, whereby our November payment has been deferred to December 17, 2012, at which time we will be obligated to pay them $20.0 million. We have also negotiated a revision to our forbearance agreement with HBO, whereby we will make a current payment of $1.5 million to them, representing a partial payment of our November obligation, defer the balance to December and owe them a payment of $6.0 million on December 17, 2012. The Company has obtained the consent of the requisite lenders to revise such forbearance agreements. If we are unable to obtain sufficient liquidity to make such payments, which is likely, or such payments are not further deferred, we would be forced to file under Chapter 11 of the U.S. Bankruptcy Code in December. The Company is in active negotiations with its lenders and a potential investor in an effort to structure an orderly bankruptcy process.

From October 1 to November 8, 2012, we have made aggregate payments to our vendors of approximately $28 million, in addition to the aggregate payments of approximately $24 million made between September 15 and September 30, 2012, to address the extended payment terms many of our vendors were operating under and to comply with the forbearance agreements negotiated with DirecTV and HBO. Additionally, the Company has retained legal and financial advisors and paid fees of $3.5 million to them to assist in the restructuring of our Credit Facility and exploring strategic alternatives. Also, as required by the Forbearance Agreement with our lenders, we have also paid more than $500,000 to the financial and legal advisors retained by the lenders’ Steering Committee.

As a consequence of our liquidity situation, our Board of Directors did not declare a dividend on the preferred stock, with respect to the third quarter and does not expect to declare or pay any further dividends on the preferred stock.

The issues outlined above have contributed to a situation where the Company is having difficulties meeting its ongoing financial obligations. Our ability to continue as a going concern is dependent upon maintaining adequate liquidity levels and satisfying our vendor obligations, a successful refinancing or restructuring of our existing Credit Facility, or finding alternative financing through a potential sale transaction with a third-party. There can be no assurance that the Company will be successful in achieving such refinancing or restructuring, obtaining acceptable financing or maintaining adequate liquidity to satisfy vendor obligations. Consequently, the Company is exploring all other options available including filing under Chapter 11. In the event the Company was to make such a filing, there can be no assurance that the common equity or the preferred equity would have any value. As a result, the common equity might be cancelled without the holders thereof receiving any distribution in a Chapter 11 case, and the preferred equity might also be cancelled without any assurance that the holders thereof would receive any distributions. If the preferred shareholders were to receive a distribution, there can be no assurance as to the value of any such distribution.

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Please refer to “Part I. Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 and “Part II Item 1A Risk Factors” in this Form 10-Q for further details regarding risks relating to our sufficiency of cash flows, indebtedness and covenants.

We are currently engaged in negotiations with a group of lenders and with certain third parties regarding restructuring options, including a potential sale transaction to a third-party that would restructure our existing Credit Facility with a combination of extended maturity dates and a new equity contribution which would involve a change in control of the Company, and likely would include a filing under Chapter 11.

Obligations and commitments as of September 30, 2012 were as follows (dollar amounts in thousands):

			Payments due by period
			Less than		2 – 3		4 – 5		Over
	Total		1 year		years		years		5 years
Contractual obligations:
Long-term debt(s)	$	347,386	$	346,741	$	536	$	109	$	-
Interest on long-term debt (1)	7,749		7,731		17		1		-
Operating lease payments	2,519		965		1,313		241		-
Purchase obligations and royalties (2)	50,617		48,586		1,809		222		-
Total contractual obligations	$	408,271	$	404,023	$	3,675	$	573	$	-

			Amount of commitment expiration per period
			Less than		2 – 3		4 – 5		Over
	Total		1 year		years		years		5 years
Other commercial commitments:
Standby letters of credit	$	350	$	350	$	-	$	-	$	-

(1) Interest payments are estimates based on current LIBOR, Forbearance Agreement interest rates and scheduled debt amortization.

(2) Consists of open purchase orders and commitments and programming-related minimum guarantees for specific periods or individual programming content.

Hospitality and Advertising Services Businesses

Our Hospitality and Advertising Services businesses include television content sold to hotels and/or the respective hotels’ guests. The products can include interactive video-on-demand (“VOD”), cable television programming, Internet services or advertising services, and have an analogous consumer base. All products and services are delivered through a proprietary system platform having related satellite communication technology, and are geared towards the hotels and their guests.

Guest Entertainment (includes purchases for on-demand movies, network-based video games, music and music videos and television on-demand programming). One of our main sources of revenue, generating 47.3% of total revenue for the quarter ended September 30, 2012, is providing in-room, interactive guest entertainment, for which the hotel guest pays on a per-view, hourly or daily basis.

Our total guest-generated revenue depends on a number of factors, including:

· The number of rooms on our network. Our ability to maintain our room base is dependent on a number of factors, including the number of newly constructed hotel properties or properties serviced by a competitor, and the attractiveness of our technology, service and support to hotels currently serviced by us.

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· The occupancy rate at the property. Our revenue also varies depending on hotel occupancy rates, which are subject to a number of factors, including seasonality, general economic conditions and world events, such as terrorist threats or public health issues. Occupancy rates for the properties we serve are typically higher during the second and third quarters due to seasonal travel patterns. We target higher occupancy properties in diverse demographic and geographic locations in an effort to mitigate occupancy-related risks.

· The buy rate of hotel guests. This is impacted by a number of issues, some of which are not under our control. Specific issues impacting buy rate include:

· The number of rooms equipped with our interactive high-definition television (“iHDTV”) systems. We typically earn higher revenue from a property when we convert it to our iHDTV platform. Our ability to expand our iHDTV room base is dependent on a number of factors, including availability of capital resources from the hotels and us to invest in HD televisions and equipment. We are focused on accelerating the installation of our iHDTV systems as hotels increase their purchase of HD televisions.

· The popularity, timeliness and amount of content offered at the hotel. Our revenues vary, to a certain degree, with the number, timeliness and popularity of movie content available for viewing, and whether the content is presented in digital or analog format. Historically, a decrease in the availability of popular movie content has adversely impacted revenue, and the availability of high definition content has increased revenue. Although not completely within our control, we seek to program and promote the most popular available movie content and other content to maximize our revenue and profitability.

· The price of the service purchased by the hotel guest. Generally, we control the prices charged for our products and services, and manage pricing in an effort to maximize revenue and overall profitability. We establish pricing based on such things as the demographics of the property served, the popularity of the content and overall general economic conditions. Our technology enables us to measure the popularity of our content and make decisions to best position such content and optimize revenue from such content.

· The effectiveness of our promotional and marketing campaigns. We believe we can promote increased browsing activity through: tiered pricing; an improved user interface and navigational experiences for hotel guests; and enhanced merchandising and marketing of the latest content in our exclusive hotel window. By increasing browsing activity, attracting new buyers and lifting buy rates, we believe we can improve theatrical movie revenue per room. Certain merchandising and promotional pricing programs may, in some cases, have a negative impact on revenue before they are modified or suspended.

· The availability of alternative programming and portable devices. We compete directly for customers with a variety of other content providers delivering content across different portable devices. Competing content providers include cable and satellite television companies; Internet streaming services, including Netflix, Hulu and Amazon; and Internet websites which provide access to free adult content, including streaming video. These sources of alternative content can be delivered across a variety of portable viewing devices, such as laptop computers, smart phones and iPads®.

· Consumer sentiment. The willingness of guests to purchase our entertainment services is also impacted by the general economic environment and its impact on consumer sentiment. Historically, such impacts were not generally material to our revenue results; however, since the last half of 2008, economic conditions have had a significant, negative impact on our revenue levels.

The primary direct costs of providing Guest Entertainment are:

· license fees paid to major motion picture studios, which are variable and based on a percent of guest-generated revenue, for non-exclusive distribution rights of recently released major motion pictures;

· commissions paid to our hotel customers, which are also variable and based on a percent of guest-generated revenue;

· license fees, which are based on a percent of guest-generated revenue, for television on-demand, music, music videos, video games and sports programming; and

· fixed monthly Internet connectivity costs.

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Key Metrics:

Rooms Served

One of the metrics we monitor within our Hospitality and Advertising Services businesses is the number of rooms we serve with our various services. As of September 30, we had the following number of rooms installed with the designated service:

	September 30,
	2012	2011
Total rooms served (1)	1,518,417	1,693,745
Total Guest Entertainment rooms (2)	1,387,104	1,551,204
Total iHDTV rooms (3)	353,143	294,396
Percent of Total Guest Entertainment rooms	25.5%	19.0%
Total Envision rooms (4)	75,051	5,087
Percent of Total Guest Entertainment rooms	5.4%	0.3%
Total Mobile rooms (5)	639,955	-
Percent of Total Guest Entertainment rooms	46.1%	-
Total Cable Television Programming (FTG) rooms (6)	879,264	960,965
Percent of Total Guest Entertainment rooms	63.4%	61.9%
Total Broadband Internet rooms (7)	103,844	150,581

(1) Total rooms served include rooms receiving one or more of our services, including rooms served by international licensees.

(2) Guest Entertainment rooms, of which 94.1% were digital as of September 30, 2012, receive one or more Guest Entertainment services, such as movies, video games, music or other interactive and advertising services.

(3) iHDTV rooms are equipped with high-definition capabilities.

(4) Guest Entertainment rooms installed with our Envision interactive platform.

(5) Guest Entertainment rooms compatible with the LodgeNet Mobile App.

(6) Cable television programming (FTG) rooms receive basic or premium cable television programming.

(7) Represents rooms receiving high-speed Internet service.

High Definition Room Growth

We also track the penetration of our interactive, high-definition television (“iHDTV”) system, since rooms equipped with iHDTV services typically generate higher revenue from Guest Entertainment and Hotel Services than rooms equipped with our analog systems. iHDTV room growth occurs as we install our iHDTV system in newly contracted rooms or convert certain existing rooms to the iHDTV system in exchange for contract extensions. The installation of an iHDTV system typically requires a capital investment by both the Company and the hotel operator. During the past three years, iHDTV growth has been constrained by reduced hotel capital spending on HD televisions, given the negative impact of the economy on the hospitality industry and is currently constrained by our liquidity issues. We installed our iHDTV systems in the following number of net new rooms as of September 30:

	September 30,
	2012	2011

Net new iHDTV rooms for the three months ended	11,510	8,801
Net new iHDTV rooms for the nine months ended	43,904	24,043

iHDTV rooms, including new installations and major upgrades, are equipped with high-definition capabilities.

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Capital Investment Cost Per Installed Room

The average investment cost per room associated with an installation can fluctuate due to engineering efforts, component costs, product segmentation, cost of assembly and installation, average number of rooms for properties installed, certain fixed costs and hotel capital contributions. The following table sets forth our average installation cost per room during the periods ended:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011

Average cost per installed iHDTV room	$	141	$	135	$	141	$	144

Average Revenue Per Room

We monitor the average revenue we generate per Hospitality and Advertising Services room. Guest Entertainment revenue can fluctuate based on several factors, including occupancy, consumer sentiment, mix of travelers, the availability of high definition and alternative programming, the popularity of movie content, the mix of services purchased and the overall economic environment. Hotel Services revenue can fluctuate based on the percentage of our hotels purchasing cable television programming services from us, the type of services provided at each site, as well as the number of hotels purchasing Internet service and support from us. System Sales and Related Services revenue can fluctuate based on the number of system and equipment sales, including Internet systems sales. Advertising Services revenue can fluctuate based on the demand for advertising and the performance of products and services sold to business and leisure travelers, as well as the number of rooms available to promote within. The following table sets forth the components of our Hospitality and Advertising Services revenue per room for the three and nine months ended September 30:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011
Average monthly revenue per room:
Hospitality and Advertising Services
Guest Entertainment	$	10.23	$	11.88	$	10.22	$		11.74
Non-Guest Entertainment
Hotel Services	7.41		7.03		7.39		6.98
System Sales and Related Services	2.94		2.43		2.92		2.15
Advertising Services	0.35		0.50		0.33		0.49
	10.70		9.96		10.64		9.62
Total Hospitality and Advertising Services revenue per room	$	20.93	$	21.84	$	20.86	$	21.36

Our diversified revenue initiatives, including Hotel Services, Systems Sales and Related Services and Advertising Services, increased to $10.70 per room for the current quarter, a 7.4% increase from the prior year quarter. Quarter over quarter, Guest Entertainment revenue per room decreased 13.9% to $10.23. For the nine months ended September 30, 2012, revenue from diversified initiatives increased to $10.64 per room, a 10.6% increase from the prior year period. During the same period, Guest Entertainment revenue per room decreased 12.9% to $10.22. Total Non-Guest Entertainment revenue, including Healthcare, comprised 52.7% of total revenue during the third quarter of 2012 and 52.6% of total revenue for the nine months ended September 30, 2012.

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Average Direct Costs Per Room

Guest Entertainment direct costs vary based on content license fees, the mix of Guest Entertainment products purchased and the commission earned by the hotel. Hotel Services direct costs include the cost of cable television programming and the cost of Internet support services. The cost of System Sales and Related Services primarily includes the cost of the systems and equipment sold to hotels. Advertising Services direct costs include the cost of developing and distributing programming. The overall direct cost margin primarily varies based on the composition of revenue. The following table sets forth our Hospitality and Advertising Services direct costs per room for the three and nine months ended September 30:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2012			2011		2012		2011
Average monthly direct costs per room:
Hospitality and Advertising Services
Guest Entertainment	$	4.32		$	4.84	$	4.13	$	4.61
Hotel Services	6.23			5.79		6.21		5.79
System Sales and Related Services	2.16			1.39		2.12		1.37
Advertising Services	0.04			0.27		0.05		0.26
Total Hospitality and Advertising Services direct costs per room	$		12.75	$	12.29	$	12.51	$	12.03

Healthcare Business

The healthcare market in the United States consists of over 940,000 hospital beds across approximately 5,800 facilities. We believe most hospitals currently do not have any form of interactive television services. The primary reasons hospitals purchase interactive television systems are to increase patient satisfaction, to improve clinical outcomes and to increase operational efficiencies. Our Healthcare revenue is generated through a variety of services and solutions provided to care facilities, including:

· revenue generated from the sale of the interactive system hardware, software licenses and installation services;

· revenue from the sale and installation of satellite television equipment and related programming;

· revenue from recurring support agreements for interactive content, software maintenance and technical field service support, including service agreements covering cable plant, satellite television equipment and interactive systems; and

· revenue generated from cable plant design, modification and installation, as well as television installation services.

As of September 30, these services and solutions were installed as follows:

	September 30,
	2012	2011
Systems installed	78	63
Beds served	18,216	14,887

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General Operations

Total Operating Expenses

System operations expenses consist of costs directly related to the operation and maintenance of systems at hotel sites. Selling, general and administrative expenses (“SG&A”) primarily include payroll costs, share-based compensation, engineering development costs and legal, marketing, professional and compliance costs. The following table sets forth the components of our operating expenses per room for the three and nine months ended September 30:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011
Systems operations expenses	$	1.97	$	2.05	$	1.97	$	2.02
SG&A expenses	2.08		2.16		2.23		2.10
Depreciation and amortization (D&A)	3.27		3.58		3.64		3.71
Impairment charge	-		-		7.16		-
Restructuring charge	0.25		0.15		0.40		0.13
Other operating expense, net	-		0.01		-		-
	$	7.57	$	7.95	$	15.40	$	7.96

Systems operations as a percent of total revenue	9.1%		9.1%		9.1%		9.2%
SG&A as a percent of total revenue	9.6%		9.7%		10.3%		9.6%
D&A as a percent of total revenue	15.1%		16.0%		16.8%		17.0%
Total operating expenses as a percent of total revenue	35.0%		35.5%		71.4%		36.3%

Seasonality

Our quarterly operating results are subject to fluctuation, depending upon hotel occupancy rates and other factors, including travel patterns and the economy. Our hotel customers typically experience higher occupancy rates during the second and third quarters, due to seasonal travel patterns and, accordingly, we historically have higher revenue and cash flow in those quarters. However, quarterly revenue can be affected by the availability of popular content during those quarters and by consumer purchasing behavior. We have no control over when new content is released or how popular it will be, or the effect of economic conditions on consumer behavior.

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Discussion and Analysis of Results of Operations

Three Months Ended September 30, 2012 and 2011

Revenue Analysis. Total revenue for the third quarter of 2012 was $91.2 million, a decrease of $15.6 million or 14.6%, compared to the third quarter of 2011. The decrease in revenue was from Guest Entertainment, Hotel Services and Advertising Services revenues, partially offset by an increase in revenues from System Sales and Related Services and Healthcare. The following table sets forth the components of our revenue (dollar amounts in thousands) for the quarter ended September 30:

	2012				2011
				Percent				Percent
				of Total				of Total
	Amount			Revenues	Amount			Revenues
Revenues:
Hospitality and Advertising Services
Guest Entertainment	$	43,158		47.3%	$	56,691		53.1%
Hotel Services	31,226			34.2%	33,555			31.4%
System Sales and Related Services	12,384			13.6%	11,587			10.8%
Advertising Services	1,479			1.6%	2,366			2.2%
Total Hospitality and Advertising Services	88,247			96.7%	104,199			97.5%
Healthcare	2,983			3.3%	2,648			2.5%
	$		91,230	100.0%	$		106,847	100.0%

Hospitality and Advertising Services revenue, which includes Guest Entertainment, Hotel Services, System Sales and Related Services and Advertising Services, decreased $16.0 million or 15.3%, to $88.2 million in the third quarter of 2012 compared to $104.2 million in the third quarter of 2011. Average monthly Hospitality and Advertising Services revenue per room was $20.93 in the third quarter of 2012, a decrease of 4.2% as compared to $21.84 in the prior year quarter. The following table sets forth information with respect to Hospitality and Advertising Services revenue per room for the quarter ended September 30:

	2012		2011
Average monthly revenue per room:
Hospitality and Advertising Services
Guest Entertainment	$	10.23	$	11.88
Hotel Services	7.41		7.03
System Sales and Related Services	2.94		2.43
Advertising Services	0.35		0.50
Total Hospitality and Advertising Services revenue per room	$	20.93	$	21.84

Guest Entertainment revenue, which includes on-demand entertainment such as movies, television on-demand, music and games, decreased $13.5 million or 23.9%, to $43.2 million in the third quarter of 2012 as compared to $56.7 million in the prior year quarter. The decrease in revenue resulted primarily from an 11.6% reduction in the average number of Guest Entertainment rooms served and a 13.9% decline in Guest Entertainment revenue per room, which primarily resulted from a decline in revenue from Hollywood and non-theatrical movies, television on-demand programming, video games and music. As a result, monthly Guest Entertainment revenue for the third quarter of 2012 declined to $10.23 compared to $11.88 for the third quarter of 2011. On a per-room basis, average monthly movie revenue per room was $9.69 for the third quarter of 2012, a 13.4% reduction as compared to $11.19 per room in the prior year quarter. Non-movie Guest Entertainment revenue per room decreased 21.7% to $0.54 in the third quarter of 2012, driven primarily by decreases in television on-demand, games and music revenue.

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Hotel Services revenue, which includes recurring revenue from hotels for cable television programming and Internet service and support, decreased $2.4 million compared to the prior year quarter, to $31.2 million in the third quarter of 2012 versus $33.6 million in the third quarter of 2011. On a per-room basis, monthly Hotel Services revenue for the third quarter of 2012 increased 5.4%, to $7.41 compared to $7.03 for the third quarter of 2011. Monthly cable television programming revenue per room increased 5.7%, to $6.81 for the third quarter of 2012 as compared to $6.44 for the third quarter of 2011. These increases resulted primarily from an increase in the number of rooms receiving HD service and the expiration of contracts with unfavorable terms. Recurring Internet revenue per room declined, to $0.54 in the current quarter from $0.59 in the prior year quarter.

System Sales and Related Services revenue includes the sale of cable television programming equipment, Internet equipment, HDTV installations and other services to hotels. For the third quarter of 2012, revenue increased $0.8 million or 6.9%, to $12.4 million as compared to $11.6 million for the third quarter of 2011. The improvement was the result of increased television programming systems sales, offset in part by fees received in 2011 related to the early termination of a group of limited service hotels which elected to only provide free television.

Advertising Services revenue consists of revenue generated by our advertising services subsidiary. For the third quarter of 2012, revenue decreased $0.9 million or 37.5%, to $1.5 million as compared to $2.4 million in the prior year period. This decrease was primarily the result of the transition of our analog system to a high-definition platform.

Healthcare revenue includes the sale of interactive systems and services to healthcare facilities. Healthcare revenue increased $0.4 million or 12.7%, to $3.0 million in the third quarter of 2012 compared to $2.6 million in the third quarter of 2011. The increase was the result of an increase in the number of beds receiving our recurring services and increased professional services work. During the third quarter of 2012, we installed 640 beds and three facilities compared to 1,148 beds and three facilities during the prior year period.

Direct Costs (exclusive of operating expenses and depreciation and amortization discussed separately below). Total direct costs decreased $4.8 million or 8.0%, to $55.2 million in the third quarter of 2012 as compared to $60.0 million in the third quarter of 2011. Total direct costs were 60.5% of revenue for the third quarter of 2012 as compared to 56.2% in the third quarter of 2011, increasing primarily due to a change in the mix of products and services sold. Direct costs related to the Hospitality and Advertising Services businesses, which include Guest Entertainment, Hotel Services, System Sales and Related Services and Advertising Services, were $53.8 million for the third quarter of 2012 compared to $58.6 million for the prior year quarter. We had a lower sales volume in Guest Entertainment and Hotel Services, resulting in lower hotel commissions, royalties and programming fees. Advertising Services direct costs were also lower, due to the transition of our advertising platform.

Operating Expenses. The following table sets forth information in regard to operating expenses for the quarter ended September 30 (dollar amounts in thousands):

	2012			2011
			Percent			Percent
			of Total			of Total
	Amount		Revenues	Amount		Revenues
Operating expenses:
System operations	$	8,311	9.1%	$	9,768	9.1%
Selling, general and administrative	8,770		9.6%	10,326		9.7%
Depreciation and amortization	13,777		15.1%	17,075		16.0%
Restructuring charge	1,055		1.2%	732		0.7%
Other operating (income) expense	(4)		0.0%	31		0.0%
Total operating expenses	$	31,909	35.0%	$	37,932	35.5%

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Discussion and Analysis of Results of Operations

Nine Months Ended September 30, 2012 and 2011

Revenue Analysis. Total revenue for the first nine months of 2012 was $278.7 million, a decrease of $42.5 million or 13.2%, compared to the first nine months of 2011. The decrease in revenue was from Guest Entertainment, Hotel Services and Advertising Services revenues, partially offset by increases in revenues from System Sales and Related Services and Healthcare. The following table sets forth the components of our revenue (dollar amounts in thousands) for the nine months ended September 30:

	2012			2011
			Percent			Percent
			of Total			of Total
	Amount		Revenues	Amount		Revenues
Revenues:
Hospitality and Advertising Services
Guest Entertainment	$	132,157	47.4%	$	172,305	53.7%
Hotel Services	95,453		34.3%	102,406		31.9%
System Sales and Related Services	37,760		13.5%	31,548		9.8%
Advertising Services	4,213		1.5%	7,164		2.2%
Total Hospitality and Advertising Services	269,583		96.7%	313,423		97.6%
Healthcare	9,127		3.3%	7,788		2.4%
	$	278,710	100.0%	$	321,211	100.0%

Hospitality and Advertising Services revenue, which includes Guest Entertainment, Hotel Services, System Sales and Related Services and Advertising Services, decreased $43.8 million or 14.0%, to $269.6 million in the first nine months of 2012 compared to $313.4 million in the first nine months of 2011. Average monthly Hospitality and Advertising Services revenue per room was $20.86 in the first nine months of 2012, a decrease of 2.3% as compared to $21.36 in the prior year period. The following table sets forth information with respect to Hospitality and Advertising Services revenue per room for the nine months ended September 30:

	2012		2011
Average monthly revenue per room:
Hospitality and Advertising Services
Guest Entertainment	$	10.22	$	11.74
Hotel Services	7.39		6.98
System Sales and Related Services	2.92		2.15
Advertising Services	0.33		0.49
Total Hospitality and Advertising Services revenue per room	$	20.86	$	21.36

Guest Entertainment revenue, which includes on-demand entertainment such as movies, television on-demand, music and games, decreased $40.1 million or 23.3%, to $132.2 million in the first nine months of 2012 as compared to $172.3 million in the prior year period. The decrease in revenue resulted primarily from an 11.9% reduction in the average number of Guest Entertainment rooms served and a 12.9% decline in Guest Entertainment revenue per room, which primarily resulted from a decline in revenue from Hollywood and non-theatrical movies, music, television on-demand programming and games. As a result, monthly Guest Entertainment revenue per room for the first nine months of 2012 declined to $10.22 compared to $11.74 for the first nine months of 2011. On a per-room basis, average monthly movie revenue per room was $9.66 for the first nine months of 2012, a 12.7% reduction as compared to $11.07 per room in the prior year period. Non-movie Guest Entertainment revenue per room decreased 16.4% to $0.56 in the first nine months of 2012, related to decreases in music and games revenue.

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Hotel Services revenue, which includes recurring revenue from hotels for cable television programming and Internet service and support, decreased $6.9 million or 6.8%, to $95.5 million during the first nine months of 2012 versus $102.4 million in the first nine months of 2011. On a per-room basis, monthly Hotel Services revenue for the first nine months of 2012 increased 5.9%, to $7.39 compared to $6.98 for the first nine months of 2011. Monthly cable television programming revenue per room increased 6.3%, to $6.78 for the first nine months of 2012 as compared to $6.38 for the first nine months of 2011. These increases resulted primarily from an increase in the number of rooms receiving HD service and the expiration of contracts with unfavorable terms. Recurring Internet revenue per room decreased slightly, to $0.57 for the current nine months as compared to $0.60 for the prior year nine months.

System Sales and Related Services revenue includes the sale of cable television programming equipment, Internet equipment, HDTV installations and other services to hotels. For the first nine months of 2012, revenue increased $6.3 million or 19.7%, to $37.8 million as compared to $31.5 million for the first nine months of 2011. The improvement was from increased television programming systems sales, professional services work and service-related revenue, partially offset by fees received in 2011 related to the early termination of a group of limited service hotels which elected to only provide free television.

Advertising Services revenue consists of revenue generated by our advertising services subsidiary. For the first nine months of 2012, revenue decreased $3.0 million or 41.2%, to $4.2 million as compared to $7.2 million in the prior year period. This decrease was primarily the result of the transition of our analog system to a high-definition platform.

Healthcare revenue includes the sale of interactive systems and services to healthcare facilities. Healthcare revenue increased $1.3 million or 17.2%, to $9.1 million in the first nine months of 2012 as compared to $7.8 million for the first nine months of 2011, driven by the number of installations and professional services work done in the current period, as well as an increase in the number of beds receiving our recurring services. During the current period, we installed 2,285 beds and 10 facilities compared to 2,663 beds and 7 facilities during the prior year period.

Direct Costs (exclusive of operating expenses and depreciation and amortization discussed separately below). Total direct costs decreased $13.4 million or 7.5%, to $167.0 million in the first nine months of 2012 as compared to $180.4 million in the first nine months of 2011. Total direct costs were 59.9% of revenue for the first nine months of 2012 compared to 56.2% for the same period in 2011, increasing primarily due to a change in the mix of products and services sold. Direct costs related to the Hospitality and Advertising Services businesses, which include Guest Entertainment, Hotel Services, System Sales and Related Services and Advertising Services, were $161.7 million for the first nine months of 2012 compared to $176.6 million for the prior year period. Lower sales volume in Guest Entertainment and Hotel Services resulted in lower hotel commissions, royalties and programming fees. Advertising Services direct costs were also lower this period, due to the transition of our advertising platform.

Operating Expenses. The following table sets forth information in regard to operating expenses for the nine months ended September 30 (dollar amounts in thousands):

	2012			2011
			Percent			Percent
			of Total			of Total
	Amount		Revenues	Amount		Revenues
Operating expenses:
System operations	$	25,455	9.1%	$	29,569	9.2%
Selling, general and administrative	28,761		10.3%	30,854		9.6%
Depreciation and amortization	47,018		16.8%	54,499		17.0%
Impairment charge	92,614		33.3%	-		-
Restructuring charge	5,221		1.9%	1,896		0.5%
Other operating (income) expense	(37)		0.0%	9		0.0%
Total operating expenses	$	199,032	71.4%	$	116,827	36.3%

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System operations expenses decreased $4.1 million or 13.9%, to $25.5 million in the first nine months of 2012 as compared to $29.6 million in the first nine months of 2011. The decrease was driven by reduced payroll, facilities, system repair and content distribution costs. As a percentage of total revenue, system operations expenses were stable, at 9.1% this period and 9.2% for the first nine months of 2011. Per average installed room, system operations expenses were $1.97 per room per month for the nine months ended September 30, 2012 and $2.02 for the nine months ended September 30, 2011.

Selling, general and administrative (“SG&A”) expenses decreased $2.1 million or 6.8%, to $28.8 million in the current period as compared to $30.9 million in the same period of 2011. The decrease was a result of lower professional services, in addition to our expense reduction initiatives, which included the reduction of personnel, other payroll-related costs and facilities expenses. As a percentage of revenue, SG&A expenses were 10.3% in the current period as compared to 9.6% in the prior year period. SG&A expenses were $2.23 per average installed room per month for the current nine months as compared to $2.10 in the first nine months of 2011.

Depreciation and amortization expenses were $47.0 million in the first nine months of 2012 as compared to $54.5 million in the first nine months of 2011. As a percentage of revenue, depreciation and amortization expenses were 16.8% in the first nine months of 2012 compared to 17.0% in the first nine months of 2011.

The declines in Guest Entertainment revenue and room base during 2012 caused the Company to reassess and update our financial plans to reflect these changes in our Hospitality business. These matters were qualitative factors impacting the recovery of our Hospitality reporting unit goodwill, and triggered an assessment of goodwill on an interim basis during the second quarter of 2012. As a result of our impairment test, we recorded a non-cash asset impairment charge in our Hospitality segment of $92.6 million related to goodwill. In addition, we recorded a $1.4 million non-cash asset impairment charge related to intangible assets in our Hospitality segment under depreciation and amortization expenses. See Note 3 to the Consolidated Financial Statements.

In 2012, we implemented reorganization initiatives to gain operating efficiencies by reducing the number of service operation locations and reorganizing departments and management structure. These initiatives included a reduction in workforce, by approximately 11%, and vacating leased warehouse/office facilities. As a result of these actions and executive restructuring, we incurred $5.2 million of costs during the current nine month period. As a result of our 2011 restructuring initiative, we had $1.9 million of costs during the first nine months of 2011. Additional accruals and cash payments related to the restructuring activities are dependent upon reduction in force or subleasing arrangements, which could change our expense estimates.

Operating (Loss) Income. As a result of the factors described above, operating loss was $87.3 million in the first nine months of 2012 compared to operating income of $24.0 million in the first nine months of 2011.

Interest Expense. Interest expense was $17.7 million in the current period versus $25.0 million in the first nine months of 2011. The weighted average interest rate was 6.6% for the first nine months of 2012 versus 9.0% for the first nine months of 2011. The decline in interest expense and rate was related the quarterly payments on our interest rate swap commitments during the first half of 2011. The interest rate swaps expired effective June 30, 2011. The outstanding balance of our debt under the Credit Facility and our capital lease obligations decreased to $347.4 million at September 30, 2012 from $365.6 million at September 30, 2011. Interest expense for the first nine months of 2011 included a net $1.5 million non-cash interest gain related to our interest rate swap position, including a $6.4 million gain related to the change in fair value of the swaps and $4.9 million in amortization of deferred losses frozen in other comprehensive income.

Loss on Early Retirement of Debt. During the first nine months of 2012, we made additional prepayments on our term loan totaling $32.0 million. As a result of these prepayments, we expensed $312,000 of unamortized debt issuance costs. During the first nine months of 2011, we made an additional prepayment on our term loan of $2.0 million. As a result of this prepayment and the First Amendment to our Credit Facility, we expensed $158,000 of unamortized debt issuance costs.

Taxes. For the first nine months of 2012 and 2011, we incurred taxes of $508,000 and $725,000, respectively, primarily for state franchise taxes and foreign income taxes.

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Critical Accounting Policies

Management’s discussion and analysis of financial condition and results of operations are based upon our financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Our primary cost drivers are predetermined rates, such as hotel commissions; license fees paid for major motion pictures and other content or one-time fixed fees for independent films; and cable television programming costs. However, the preparation of financial statements requires us to make estimates and assumptions which affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and on various other assumptions we believe to be reasonable based upon the available information. Our significant accounting policies can be found in “Part II. Item 8. Financial Statements and Supplementary Data” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. The following critical policy relates to the more significant judgments and estimates used in the preparation of the financial statements:

Goodwill Impairment. We account for goodwill and other intangible assets under FASB ASC Topic 350, “Intangibles - Goodwill and Other.” Under FASB ASC Topic 350, purchased goodwill is not amortized; rather, it is tested for impairment annually. We perform our goodwill impairment test for each reporting unit during the fourth quarter. Impairment testing could occur more frequently if there is a triggering event or change in circumstances which indicate the carrying value may not be recoverable, such as a significant deterioration in market conditions.

We operate in three reportable segments, which also represent our reporting units, Hospitality, Advertising Services and Healthcare, for which only Hospitality and Advertising Services have goodwill. An entity may first assess qualitative factors to evaluate if the existence of events or circumstances leads to a determination it is necessary to perform the current two-step goodwill impairment test. After assessing the totality of events or circumstances, if it is determined it is more likely than not the fair value of a reporting unit is less than its carrying amount, then the two-step impairment test must be performed for that reporting unit or units. An entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to the two-step impairment test, and then resume performing the qualitative assessment in any subsequent period. If an entity determines it is necessary to perform the two-step test, the first step is to compare a reporting unit’s fair value to its carrying amount. Fair value measurements must take into consideration the principal or most advantageous market, the highest and best use, the valuation technique and incorporate market participant assumptions. Valuation techniques to be used to measure fair value are the market approach, income approach and/or cost approach, and must be based on market participant assumptions. We consider the income approach to be a more meaningful indicator of fair value over the use of the market and cost approaches, due to a lack of comparable companies and assets. Using the income approach, we utilize a discounted cash flow analysis based on key assumptions and estimates. We also reconcile the aggregate reporting units’ fair values to the Company’s indicated market capitalization. Key assumptions used to determine fair value include projections of revenue and cost data, capital spending, growth and operating earnings, factored for certain economic conditions. Certain costs within the reporting units are fixed in nature; therefore, changes in revenue which exceed or fall below the fixed cost threshold would have an effect on cash flow and recoverability of goodwill.

If the carrying amount is positive and does not exceed the reporting unit’s fair value, no impairment loss exists. If the carrying amount exceeds the reporting unit’s fair value, the second step (Step 2) is to be performed. Reporting units with zero or negative carrying amounts are required to perform Step 2 of the goodwill impairment test if it is more likely than not goodwill impairment exists. In considering whether it is more likely than not an impairment loss exists, a company would evaluate qualitative factors, including the same factors which would trigger an interim impairment test of goodwill. Factors include a significant deterioration in market conditions, unanticipated competition, a significant decline in revenue and margin or an anticipated sale of a reporting unit. If an entity determines it is more likely than not an impairment exists, Step 2 of the impairment test must be performed for that reporting unit or units. Step 2 involves allocating the fair value of the reporting unit to each asset and liability, with the excess being implied goodwill. An impairment loss occurs if the amount of the recorded goodwill exceeds the implied goodwill.

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The declines in Guest Entertainment revenue and in our room base during 2012 have occurred at a rate greater than what we previously estimated. In addition, our market capitalization has declined during 2012. The declines in Guest Entertainment revenue and room base during the first half of 2012 caused the Company to reassess and update our financial plans to reflect these changes in our Hospitality business. These matters were qualitative factors impacting the recovery of our Hospitality reporting unit goodwill, and triggered an assessment of goodwill on an interim basis during the second quarter of 2012. As of June 30, 2012, our Hospitality reporting unit had a negative carrying value of $(85.7) million. As such, we evaluated the qualitative factors and determined it was more likely than not that an impairment existed. In Step 2 of our impairment testing, it was determined the estimated fair value of the assets and liabilities of the Hospitality reporting unit exceeded the fair value of the reporting unit, resulting in no implied goodwill. As a result of our second quarter impairment test, we recorded a non-cash asset impairment charge in our Hospitality segment of $92.6 million related to goodwill. In addition, we recorded a $1.4 million non-cash asset impairment charge related to intangible assets in our Hospitality segment under depreciation and amortization expenses. We believe there are no current impacts to our Advertising Services reporting unit. We have concluded that our liquidity constraints have not resulted in any intangible asset impairments as of September 30, 2012.

Recent Accounting Developments

See Note 16 to the Consolidated Financial Statements.

Item 3 — Quantitative and Qualitative Disclosures About Market Risk

We are exposed to various market risks, including potential losses resulting from adverse changes in interest rates and foreign currency exchange rates. We do not enter into derivatives or other financial instruments for trading or speculative purposes.

At September 30, 2012, we had debt totaling $347.4 million as follows (dollar amounts in thousands):

	Carrying		Fair
	Amount		Value
Credit Facility:
Term loan	$	325,407	$	244,055
Revolving loan commitment	21,000		21,000
Capital leases	979		979
	$	347,386	$	266,034

The fair value of our long-term debt is estimated based on current interest rates for similar debt of the same remaining maturities and quoted market prices, except for capital leases and our revolving loan commitment borrowings, which are reported at carrying value. For our capital leases and revolving loan commitment borrowings, the carrying value approximates the fair value. In addition, the fair value of our long-term debt is strictly hypothetical and not indicative of what we are required to pay under the terms of our debt instruments.

The term loan interest rate as of September 30, 2012 was 6.5%, the revolving loan commitment rate was 7.25%, the capital lease interest rate was 3.6% and our weighted average interest rate for the quarter ended September 30, 2012 was 6.6%. Effective September 30, 2012, under the Forbearance Agreement the term loan and revolver will bear an additional 2.0% margin, for total interest rates of 8.5% and 9.25%, respectively. As of September 30, 2012, we had fixed rate debt of $1.0 million and variable rate debt of $346.4 million. For fixed rate debt, interest rate fluctuations affect the fair market value but do not impact earnings or cash flows. Conversely, for variable rate debt, interest rate fluctuations generally do not affect the fair market value but do impact future earnings and cash flows, assuming other factors are held constant. There would be no impact on earnings and cash flow for the next year resulting from a one percentage point increase to interest rates, assuming other variables remain constant, due to our LIBOR floor of 1.5%.

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In addition, our inability to comply with the existing financial covenants under our Credit Facility combined with uncertainty over our ability to remain in compliance with the covenants under the Credit Facility, and the ability of our lenders to require payment of amounts outstanding under our Credit Facility on December 17, 2012, have raised substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent upon maintaining adequate liquidity levels and satisfying our vendor obligations, a successful refinancing or restructuring of our existing Credit Facility, or finding alternative financing through a potential sale transaction with a third-party. There can be no assurance that the Company will be successful in achieving such refinancing or restructuring, obtaining acceptable alternative financing or maintaining adequate liquidity to satisfy vendor obligations. Consequently, the Company is exploring all other options available including filing under Chapter 11. In the event the Company were to make such a filing, there can be no assurance that the common equity or the preferred equity would have any value and, as a result, such common equity might be cancelled without the holders thereof receiving any distribution in a Chapter 11 case, and such preferred equity might also be cancelled without any assurance that the holders thereof would receive any distributions. If the preferred shareholders were to receive a distribution, there can be no assurance as to the value of any such distribution.

In 2012, our practice of making additional debt payments was achieved in part by delaying certain payments to our vendors, including major vendors such as DirecTV and HBO. In order to maintain continued service from these vendors, we entered into forbearance agreements with such vendors, which required payments to both vendors between September and December 2012. According to the agreements, our next payments of $10.0 million and $4.0 million to DirecTV and HBO, respectively, would have been due on November 15, 2012, and we did not expect to have the necessary liquidity to make such payments and maintain our operations. Consequently, we have negotiated a revision to our forbearance agreement with DirecTV, whereby our November payment has been deferred to December 17, 2012, at which time we will be obligated to pay them $20.0 million. We have also negotiated a revision to our forbearance agreement with HBO, whereby we will make a current payment of $1.5 million to them, representing a partial payment of our November obligation, defer the balance to December and owe them a payment of $6.0 million on December 17, 2012. If we are unable to obtain sufficient liquidity to make such payments, which is likely, we would be forced to file under Chapter 11.

Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3 — Defaults Upon Senior Securities

See Notes 1 and 6 to the Consolidated Financial Statements.

Item 4 — Mine Safety Disclosures

Not applicable.

Item 5 — Other Information

Not applicable.

Item 6 — Exhibits

31.1		Rule 13a-14(a)/15(d)-14(a) Certification of Chief Financial Officer
31.2		Rule 13a-14(a)/15(d)-14(a) Certification of Chief Executive Officer
32		Section 1350 Certifications
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema
101.CAL		XBRL Taxonomy Extension Calculation Linkbase
101.DEF		XBRL Taxonomy Extension Definition Linkbase
101.LAB		XBRL Taxonomy Extension Labels Linkbase
101.PRE		XBRL Taxonomy Extension Presentation Linkbase

Page 46

	LodgeNet Interactive Corporation

		(Registrant)



Date: November 9, 2012	/ s / Richard L. Battista

	Richard L. Battista
	President, Chief Executive Officer
	(Principal Executive Officer)



Date: November 9, 2012	/ s / Frank P. Elsenbast

	Frank P. Elsenbast
	Senior Vice President, Chief Financial Officer
	(Principal Financial & Accounting Officer)

		Page
		No.

Part I. Financial Information

Item 1 — Financial Statements:
	Consolidated Balance Sheets (Unaudited) as of September 30, 2012 and December 31, 2011	3
	Consolidated Statements of Operations (Unaudited) for the Three and Nine Months Ended September 30, 2012 and 2011	4
	Consolidated Statements of Comprehensive Income (Unaudited) for the Three and Nine Months Ended September 30, 2012 and 2011	5
	Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2012 and 2011	6
	Notes to Consolidated Financial Statements (Unaudited)	7
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 3 — Quantitative and Qualitative Disclosures About Market Risk		43
Item 4 — Controls and Procedures		44

Part II. Other Information

Item 1 — Legal Proceedings		45
Item 1A — Risk Factors		45
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds		46
Item 3 — Defaults Upon Senior Securities		46
Item 4 — Mine Safety Disclosures		46
Item 5 — Other Information		46
Item 6 — Exhibits		46

Signatures		47